The Pound resumed its upside momentum against the Dollar yesterday, rising to a high of $1.5510 on the session, while the UK currency also strengthened for a third straight day versus the Euro after a bounce in global stocks helped boost demand for risk appetite and spur demand for higher yielding assets.
Sterling subsequently climbed against 14 out of the 16 most actively traded currencies as the FTSE 100 Index gained 2.1% to record its third advance in three days, while a report from the Nationwide Building Society showed that UK house prices declined less than initial forecasts in November.
A slump in global growth and almost $1 trillion of losses and writedowns at financial institutions has fuelled demand for the relative safety of government backed bonds but the incredible injection of emergency funding by Central Banks worldwide has created an element of risk appetite that will continue to support Sterling in the short-term.
The rally in UK stocks is providing a supportive environment for the Pound and yesterday’s move may also be exacerbated by the lack of the liquidity in the market due to the U.S Thanksgiving Day holiday and therefore Sterling may be unable to sustain this recent momentum due to the deteriorating outlook for the economy.
The Pound has declined nearly 25% in value against the Dollar this year and a further 12% versus the Euro as the global financial crisis and slumping house prices sent the UK economy into the grip of a recession that may last well into 2009 according to recent estimates by the Banking of England.
The Bank’s forecasts confirm that the economy has probably fallen into a recession in the third quarter and the slump in growth is expected to last until the middle of 2009 as policy makers are seemingly prepared to cut interest rates to whatever level deemed necessary in order to revive growth.
The bright side of the Pound’s monumental decline in value does have its advantages as a weaker currency will improve the competitiveness of UK exporters and that should help improve output even as global demand shrinks.
UK house prices have fallen for a 13th consecutive month in November as the ongoing financial turmoil and restricted lending conditions deterred homebuyers, while consumer spending has fallen by the most since 1995 in the third quarter and unemployment rose higher.
The impact of the credit crunch is filtering through to the high street as the decline in spending has culminated in reports that Woolworths Plc placed its stores into administration, while MFI Retail Ltd collapsed and put at risk almost 30,000 UK jobs.
The average cost of a home in Britain fell a further 0.4% from October and an unprecedented 13.9% from this stage in 2007 and although the drop was smaller than anticipated, the report indicates that prices will continue to fall over the coming months as Banks struggle to pass on interest rate cuts to the consumer.
The Bank of England have cut interest rates to 3.0% in November and investors are already factoring in a further 75 basis point reduction on December 4th as policy makers try and revive growth and spur lending.
The Governor of the Bank of England Mervyn King said this week that getting banks to step up lending again “is more important than anything else at present” and that sentiment was echoed by the Deputy Governor Charles Bean, who said that the turmoil in credit market may warrant an aggressive easing in the UK interest rate.
Another member of the Bank’s monetary policy committee, David Blanchflower, also said yesterday that the Central Bank is “reacting to events” by cutting interest rates aggressively now, while proactive reductions earlier in the year would have helped the UK remain ahead of the curve and helped ease the effects of a recession.
Blanchflower was advocating the need to cut interest rates in the first quarter of this year, even as inflation accelerated to the highest level in over a decade, and was pressing for a 50 basis point reduction in October before policy makers eventually joined six other central banks and reduced the benchmark lending rate by half a percentage point.
Growth in the UK economy has contracted in the third quarter as the worst financial crisis since at least the Great Depression saw a sharp decline in consumer spending but Blanchflower’s push for lower rates put him in the minority of the nine member MPC as his colleagues focused on bringing inflation back towards target.
The Euro traded close to a three-week high against the Dollar yesterday as European stocks rallied for a fourth consecutive day and reports in Germany showed that unemployment unexpectedly declined in November.
The rise in risk appetite is supporting the Euro, while the Dow Jones Stoxx 600 Index climbed 2.4% as investors speculated that that ECB’s efforts to shore up banks and the economy will support profits.
In addition, the jobless rate in Germany unexpectedly held at 7.5%, the lowest level in 16-years as the number of people out of work falling 10,000 to 3.15 million, which was lower than anticipated and showed that another area of the economy is withstanding the worst recession in 12-years.
Elsewhere, a separate report from the European Union showed that confidence in the Euro-zone fell to a 15-year low this month even after the aggressive easing in interest rates and government stimulus measures to combat the impact of the financial crisis.
The Pound rallied to a high of $1.5478 versus the Dollar yesterday and the UK currency also reached a high of 1.1953 against the Euro as government bonds rose and sent the 10-year gilt to the lowest level in almost 20-years following a report that UK consumer spending declined by the most since 1995.
The report from the Office of National Statistics confirmed that business investment also slumped, while gross domestic product posted its first quarterly decline in 16-years to match preliminary estimates on October 24th and the UK stock market plunged for the first time in three days.
The UK economy is so heavily reliant on housing and consumer spending that the reports yesterday will only add to recent evidence that growth has slipped deep into contraction and the Chancellor Alistair Darling pledged £20 billion of tax cuts and spending this week to prevent a drop in lending and rising unemployment from exacerbating the recession.
The government and the Bank of England are working together to restore the flow of credit through the economy but the drop in value added tax may not be enough to revive spending because banks and lenders have so far failed to pass on recent interest rate cuts, while lending conditions remain restricted.
Earlier this month, the Office of National Statistics and the Confederation of British Industry announced that that UK retail sales had declined heavily and yesterday Woolworths Plc, the century old UK retailer, will enter administration tonight, according to a report from the BBC.
Elsewhere, a separate report showed that UK industrial production fell by 1.1% in the official figures for the third quarter and factory output also declined 1.3% to indicate that slump in spending and production will make it increasingly difficult for the government to revive growth.
The Pound declined in the aftermath of the report and endured a volatile session against the major currencies but the Bank of England Deputy Governor Charles Bean said on Tuesday that the Pound’s slide this year is the “right sort of magnitude” as the decline in value is necessary as part of the rebalancing process.
Nevertheless, Bean also added that “there is a distinction between a decline in Sterling that is necessary and one where external investors lose faith in the policy framework the UK operates under and that results in pressure on Sterling.
The Bank of England are actively talking down the Pound as Bean’s comments mirror the tone of Mervyn King’s recent statement and Geoffrey Yu, current strategist at UBS AG, said that there is an inherent risk that the Pound will fall further from its current level as the Bank of England continue cutting interest rates from the current 3.0%.
The decline in UK fundamentals illustrates that the UK economy is in a state of contraction and the global recessionary concerns combined with an aggressive easing in UK interest rates has seen the Pound decline 25% in value against the Dollar this year and the UK currency may struggle to build on the positive momentum earlier this week.
A slump in the global economy and roughly $1 trillion of losses and writedowns at financial institutions due to the credit crisis has fuelled demand for the security of government fixed-income this year, while traders have actively sold high-yielding assets as an element of risk aversion invaded the market.
To that end, the Pound may decline towards 1.1500 versus the Euro over the next quarter as interest rate cuts and a deteriorating budget deficit weighs on sentiment, while investors are speculating on the depth of the cuts with policy makers expected to lower the benchmark lending rate to at least 1.5%.
The Euro suffered a strong intraday decline against both the Pound and the Dollar yesterday amid reports that the European Union will announce a coordinated €200 billion financial stimulus package and said that more may be needed to limit the impact of the current financial crisis.
Many regions within the Euro-zone have already fallen into recession, including Germany, but the proposal yesterday is equivalent to 1.5% of European gross domestic product and is the latest initiative in a series of measures to counter the impact of an economic slump that has essentially shut down lending.
In terms of economic data, inflation in Germany dropped by the most since records began 12-years ago after oil prices plunged from the July high of $147.27 a barrel to just $54.23 by the close of trading in New York and the decline in consumer prices will give the ECB scope to reduce interest rates.
The annual rate of inflation fell 1.5% from 2.5% in October and policy makers are set to reduce rates for the third time in almost two months next week in an attempt to revive the economy from its first recession in 15-years.
The focus this morning will fall on the EC economic sentiment index and the Euro may struggle against the majors for a second day as the report is forecasted to show that consumer and business confidence slipped further into negative territory.
The Dollar rallied higher against the Euro for the first time in four days yesterday as drops in US consumer spending, durable goods orders and new home sales painted a fairly gloomy outlook for the world’s largest economy, creating an element risk aversion in the market as investors sought the security of safe haven assets.
The Dollar also rallied against the Pound in the afternoon session, trading as low as $1.5177 in New York as the deepening U.S recession encouraged investors to sell high-yielding assets in favour of low cost loans in Japan.
U.S consumer spending is the biggest contributor to the economy and reports yesterday showed that sales slipped 1% last month, which was more than initial forecasts, while new home sales fell to an annual pace of 433,000, the lowest level in 17-years.
Elsewhere, orders for durable goods slumped a massive 6.2% in October following a 0.2% decline in September to further emphasise the current recessionary concerns in the U.S economy and that prompted the Federal Reserve to commit up to $800 billion in new funding to help unfreeze credit for homebuyers, consumer and small businesses.
The Pound bounced back against the majors yesterday, rising above $1.5400 against the Dollar, while the UK currency also rallied from a low of 1.1675 versus the Euro after gains in stocks and an unprecedented injection of liquidity from the Federal Reserve boosted demand for higher-yielding assets.
The surprising momentum surrounding the Pound saw the UK currency climb for a third consecutive day against the Dollar as the Fed’s plan to encourage lending to consumers and revive spending boosted Asian stocks and some European equity markets.
The volatile swings in risk sentiment continues to reverberate through the foreign exchange market and the Pound has become somewhat of a barometer for risk aversion as the UK currency traded higher after the Fed’s commitment provided a sense of stability in financial markets that encouraged investors to move away from safe haven assets.
That notion is reflected in the Pound’s performance yesterday against the Yen and Swiss Franc but perhaps more significantly the UK currency closed well above the major Fibonacci retracement level at $1.5279 and to that end the Pound could gain as much as 10% versus the Dollar, according to Citigroup Global Markets Inc.
Citing charts used to track and predict currency movements, the Bank said that a rally from near the 76.4% Fibonacci retracement level of the Pound’s upward move from the low at $1.4557 to $1.5249 may indicate that Sterling is gathering momentum with investors targeting a possible gain to $1.5950 and latterly $1.6700.
The Pound also bounced from a daily low versus the Euro after sentiment dwindled following the Chancellor’s pre-budget report yesterday where Alistair Darling proposed a plan that would create the largest budget deficit among the Group of Seven industrialised nations as the government struggles to combat a recession.
The proposal was met with cynicism in the market as the Prime Minister’s plan to raise more tax from the highest earners is unlikely to generate enough money because the rich will contribute more to their private pensions, while converting more income to capital gains, wiping out most of the £1.6 billion to government hopes to raise.
The report from the Institute for Fiscal Studies also highlighted that the Labour Party fought that last election on a pledge not to increase the top rate of income tax from 40% and yesterday’s move marks the first increase in the higher rate since the 1970s.
There is also an argument on the actual benefits of lowering value added tax on small businesses and consumers as the government attempts to bolster confidence and increase spending to revive economic growth.
However, struggling companies will be understandably reluctant to pass on the cut to the public and a somewhat minor drop in VAT will probably give a small boost to consumer spending without being sufficient in bringing the economy out of the current slump.
Elsewhere yesterday, UK stocks gained for second day as the FTSE 100 Index rose 0.4% on the session, led by shares in financial firms, after the Bank of England governor Mervyn King said that policy makers are committed to reviving the flow of credit through the economy.
As a nation, the UK is hugely reliant on borrowing as a means to increase spending but the worsening credit conditions has made banks reluctant to step up borrowing despite a significant easing in the UK libor rate.
In a statement to the UK treasury select committee, King said that the most significant challenge to policy makers is to revive the flow of credit and insisted that the Central Bank “should not shy away from recapitalisation if that proves necessary.”
The Bank of England and the government have been working together to revive economic growth with an aggressive easing in interest rates, the biggest budget giveaway since the 1980s and a multi-billion pound government bailout for struggling financial institutions.
The failure to get banks to step up lending again could potentially increase the risk of a period of deflation and King conceded that stoking credit growth is “more important than anything else at present” and when asked about the possibility of nationalising individual UK banks, King indicated he wouldn’t rule out any such move.
The Euro relinquished earlier gains against the Pound yesterday but the single currency rose above 1.3000 versus the Dollar amid reports that German consumer confidence unexpectedly rose for a third consecutive month and defied concerns over a deepening recession.
The Gfk index for December increased to a reading of 2.2 from 1.9 in November despite initial forecasts of a 0.4% drop and the report provides an indication that consumers are taking advantage of the falling price of oil and declines in inflation.
Elsewhere, ECB governing council member Ewald Nowotny weighed into the argument on the severity of the European economic slump and even declared that the Central Bank should refrain from an aggressive cut in interest rates, favouring a wait-and-see policy.
Nowotny was joined by ECB executive board member Lorenzo Bini Smaghi, who urged policy makers to discuss a more measured response to the current economic slump, saying that “sharp” rate cuts may exacerbate negative sentiment.
The Dollar was susceptible to volatile swings in risk sentiment yesterday as the Federal Reserve took the dramatic steps to unfreeze credit markets by committing a further $800 billion in liquidity as the government seizes up to $600 billion in ‘bad’ debt and sets up $200 billion to support consumer and small business loans.
Policy makers are hopeful that the new initiative will finally bring down interest rates on mortgages and consumer loans, offsetting the withdrawal of private sector financing despite the Reserve bank slashing borrowing costs to 1.0% over the past year.
In terms of economic data, the dwindling sentiment for the Dollar as a safe haven asset drove the U.S currency lower versus both the Pound and the Euro as the economy shrank in the third quarter faster than had previously been anticipated.
Gross domestic product contracted 0.5% in the period from July to September to indicate that the world’s largest economy has sunk deeper into recession as the credit crunch, the worsening housing market and rising unemployment caused a fundamental decline in consumer and business confidence.
This week Senior Traders Adam Solomon and Luke Trevail take an in-depth look at the way the currency markets responded to the minutes from the Bank Of England Monetary Policy Committee meeting and Alistair Darling’s Pre-Budget Report.
Also this week:
The CitiBank bailout
Further Eurozone resilience
Some optimism for US Dollar buyers
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If you have any questions or comments about this Podcast please leave a comment below or call TorFX now on 0800 612 9625.
Please Note: Every effort is made to ensure the accuracy of the information contained within this communication, however TorFX cannot accept liability for damage caused by error, omission, or inaccuracies. This podcast is intended for general information and interest purposes only. Any opinions expressed are those of the individuals featured, and do not represent advice or inducements to trade.
The Pound declined against the Euro yesterday, falling to a low of 1.1714 on the session, after the UK government announced plans to sell a record amount of debt in the next fiscal year, while ten-year gilts snapped four days of consecutive gains as the cost of hedging against losses on government bonds rose to a record high.
In the pre-budget report, the Chancellor of the Exchequer Alistair Darling pledged to introduce the biggest round of tax cuts and spending increases in 20-years in an attempt to counter the UK’s first recession since 1991.
The £25.6 billion stimulus package over the next two years will swell the UK budget deficit to £118 billion in the 12 months through 2010 and at 8% of gross domestic product, the shortfall is the largest since at least 1970 and biggest within the Group of Seven nations.
The UK government is going one step further than his counterparts in the U.S, Europe and Asia as Gordon Brown tries to limit the impact of the worst global recession in 30-years and Britain’s fiscal package also includes a reduction in value added tax by 2.5 percentage points to 15% as the Labour Party try and bolster support in the build up to the election.
The giveaway in VAT is the largest initiative since 1988 when the then finance minister Nigel Lawson provided a boost equivalent to 1.2% of gross domestic product through tax cuts and the so called ‘Lawson Boom’ that followed ended in a housing bust in the early 1990s.
Yesterday’s stimulus package is equivalent to 1.1% of the economy’s value and the plans will force the government to sell a record £146.3 billion of bonds or gilts in 2008 and that represents an incredible 83% increase from the £80 billion planned just eight months ago and that puts into context the extent of the turbulence in public finances.
In order to help pay for the plan, the government also plans to raise the income tax rate for people earning more than £150,000 to 45% in 2011 and former Conservative Chancellor Kenneth Clarke said yesterday that the UK “runs the risk of having foreign exchange markets refusing to believe that the plan is credible and repayable.”
In addition, the Shadow Chancellor George Osborne commented that “this budget is all about the political cycle and not the economic cycle”, indicating that the fiscal stimulus package announced yesterday was designed to win votes rather than combat an economic slump.
Gordon Brown’s handling of the financial crisis has seen the government gain in popularity with some polls showing him narrowly leading the Conservatives in the year through September and the tax cut on higher-income earners is clearly aimed at the more traditional elements of the Labour Party.
However, the Pound failed to find any support against the majors in the aftermath of the report amid concerns that the new measures will not actually provide much of a boost to the flagging UK economy and there is an inherent risk that retailers will not pass on the saving to the consumer.
Alistair Darling also said yesterday that he wants to boost mortgage lending by guaranteeing securities backed by home loans and the plan will be based on findings from former HBOS Plc Chief Executive James Crosby who recommended the government auction roughly £100 billion in guarantees for mortgage back bonds.
According to estimates from the International Monetary Fund, the UK economy will suffer the worst slump of any G-7 nation over the next year as the decade long housing boom turns to bust and growth is forecast to contract 1.3% over the next year, compared to initial forecasts of 0.7% in the U.S and 0.5% in Germany.
The Euro made substantial gains against both the Dollar and the Pound yesterday despite reports in Germany that business confidence in the region slumped to the lowest level in almost 16-years in November as the global credit crisis weighed on demand for exports.
The Ifo Institute said its business climate index dropped to a reading of 85.8 from 90.2 in October, the lowest since February 1993, and the report will increase pressure on the European Central Bank to lower interest rates aggressively when policy makers reconvene next month.
The Dollar declined heavily against the majors yesterday, closing above $1.5150 versus the Pound, as the U.S currency suffered its biggest two-day loss against the Euro this month following reports that Citigroup Inc received a $306 billion government bailout for its troubled assets.
The rescue package protects the bank from further losses in bad assets, while injecting $20 billion of capital and bolstering the stock market value following its 60% plunge last week amid concerns that depositors may start pulling their money and destabilising the bank that operates in more than 100 countries.
The second biggest U.S bank by assets surged as much as 72% in New York in the aftermath of the Treasury’s announcement and in return for the bailout and guarantees, the government will get $27 billion of preferred shares paying an 8% dividend, which is roughly the equivalent of a 4.5% stake in the company.
Elsewhere yesterday, the President-elect Barack Obama warned that the U.S economy is “trapped in a vicious cycle” and the faces the prospect of losing “millions of jobs” unless immediate steps are taken to stimulate the economy and rescue the nation’s struggling automakers.
Obama was speaking at a press conference in Chicago and the tone of his statement was almost like a rallying cry or an ommission of the dire state of the economic outlook in the U.S as the President in waiting announced that the New York Fed President Timothy Geithner will be unveiled as the Treasury Secretary in the New Year.
In terms of economic data, the Dollar also came under further selling pressure following reports that existing home sales dropped in October and prices plunged by the most on record as the housing slump shows few signs of abating going into 2009.
Data Released 25th November
U.K 09:45 King, Bean Gieve, Bake and Sentence Testify on Inflation report
Following on from last week, the Pound endured another turbulent week against the majors with the UK currency unable to sustain any positive momentum versus the Euro and the Dollar as a sense of risk aversion stalked the market and speculation grew over the prospect of another UK interest rate cut in December.
Nevertheless, the Pound at least stemmed the flow of losses amid suggestions that the Bank of England’s aggressive easing in borrowing costs will eventually enable the UK economy to emerge faster from a recession than initially anticipated.
The UK currency snapped two weeks of declines after the governor of the BoE Mervyn King indicated that interest rates will be cut again from the current 3.0%, the lowest level since 1955, and traders are already speculating on another 75 basis point reduction on December 4th.
The degree of negative data in the UK suggests that the economy is in the grip of a recession that will probably last until 2010 as a fundamental drop in consumer spending and rising unemployment is making it harder for the government to stimulate growth, while the ongoing financial crisis means that bank’s are unwilling to increase lending.
Nevertheless, the Pound actually rallied 0.5% against the Dollar on Friday and briefly rose above 1.1900 versus the Euro despite the release of the minutes from the Bank’s last policy meeting, which showed that policy makers even considered a bigger reduction in November.
Central Banks worldwide are discussing deeper reductions in borrowing costs as the global economy stumbles through a recession and Federal Reserve policy makers predicted last week that the U.S economy will contract through mid 2009, with some members expressing willingness cut interest rates below the current 1%.
A report from the UK Office of National Statistics last week showed that consumer prices rose just 4.5% year-on-year in October, down from 5.2% the previous month, while a separate index of UK retail sales showed that consumer spending shrank 0.1% over the same period.
Both reports were largely better than initial forecasts but sales contracted for the second consecutive month and the UK inflation rate is still well above the government’s 2.0% target but the larger-than-expected drop in consumer costs will give policy makers further scope to cut interest rates in the months ahead.
Elsewhere, UK home repossessions by mortgage lenders rose 12% in the official figures for the third quarter as higher unemployment and shrinking economic growth left an increasing number of home owners unable to pay their debts.
Foreclosures increased to 11,300, compared to 10,100 in the three months through June as the Council of Mortgage Lenders, which represents British home loan providers said that applications to foreclose increased 9% and repossession orders jumped 24%.
The Pound’s trade weighted index rose 0.7% in the past week, according to indexes compiled by Deutsche Bank AG and the world’s largest currency trader predicts that the Pound will head lower against the Dollar this week but the UK currency could make some gains against the Euro with resistance at 1.1992.
Ongoing financial market turmoil, global recessionary concerns and year end factors should all influence market direction this week, while activity level should be interrupted by the Thanksgiving holiday in the U.S and the Chancellor’s pre-budget report this afternoon.
The Pound may find support should the government announce changes to the tax regime that would make repatriating overseas earnings a far more attractive option for UK companies and boost consumer sentiment.
The Chancellor Alistair Darling has the scope to cut value added tax by 2.5 percentage points to the lowest level allowed by the European Union and initial estimates show that the move will cost the treasury roughly £12 billion.
In Europe, there will also be a focus on the scope for a fiscal stimulus response to the deepening economic crisis as the EU is poised to announce the details of an “Economic Regeneration Package” early this week.
Euro-zone fundamentals will probably point to further downside risks to growth in the Euro-region and the single currency may come under further selling pressure against the majors amid suggestions that the ECB will cut interest rates more aggressively that the Bank of England.
The Dollar recorded a third weekly gain against the Euro as a plunge in global stocks increased demand for the security of U.S government debt, while higher-yielding assets such as the New Zealand and Australian Dollar declined heavily amid volatile swings in risk sentiment.
However, the weakening tone of U.S economic data suggests that the U.S recession probably deepened as consumer spending plummeted in October by the most since 2001, while the downturn in business investment saw purchases decline 1% after 0.3% fall the previous month.
The ongoing financial crisis has forced cash strapped consumers to rein in spending, while companies have cut purchases and slashed jobs as the manufacturing sector deteriorates along with housing and service sector growth to indicate that the economy is sinker further into what may be the most severe economic slump in decades.
The Dollar may weaken against the Euro this week and come under some pressure versus the Pound as speculation over a further cut in U.S interest rates will encourage foreign investors to seek higher returns elsewhere, while a barrage of weak economic reports will continue to undermine confidence in the economy.
The Pound was unable to sustain the surprising upside momentum against the Dollar from Wednesday as the UK currency relinquished all of the previous day’s gains, falling back under $1.4700 against the Dollar, and not even a smaller-than-expected drop in UK retail sale could limit the decline.
The UK currency also declined by the most in a week versus the Euro, falling to a low of 1.1764 by the close of the European session, as government bonds surged higher and a report from the Office of National Statistics showed that UK retail sales fell for a second consecutive month.
The 0.1% decline in like-for-like sales only served to increase the likelihood that policy makers will cut borrowing costs aggressively in December in an attempt to revive the floundering UK economy as it stumbles through possibly the worst recession since the end of the Second World War.
Nevertheless, the drop in sales was actually less than initial forecasts as shoppers stepped up food shopping in preparation for Christmas and that offset the lower spending on electrical goods and clothing.
Earlier predictions had forecasted that sales would tumble 0.9% from September and it was perhaps a little surprising that Sterling failed to find any support from the figure and continued the downside momentum as Marks & Spencer Group Plc warned that the current business climate is the toughest since the early 1990s.
Therefore, economists expect consumer spending to get a lot worse and rising unemployment will make it difficult for the government to revive growth even as it implements further cuts in borrowing costs and provides tax breaks to low income earners.
The recent rhetoric from a number of BoE policy makers, including the governor Mervyn King, has signalled that the Central Bank even considered cutting the benchmark lending rate below 2.5% in November before a unanimous decision to reduce rates to 3.0%, the lowest level since 1955.
Gains by government bonds subsequently pushed the yield on the two-year gilt to the lowest level in at least 16-years and the worsening economic outlook is likely to weigh heavily on Sterling over the coming months with a number of economists predicting widespread losses for Sterling against a basket of currencies.
The degree of negative sentiment for the Pound was perfectly illustrated in a recent forecast by JP Morgan & Chase Co who said that Sterling will hit $1.2800 versus the Dollar by Spring 2009, while dropping below 1.1000 against the Euro.
Nevertheless, it is not just the Bank of England that are stepping up an aggressive period of monetary easing as Central Bank’s around the world discuss deeper reductions amid a worldwide recession that has been brought about by the worst financial crisis since the Great Depression.
However, there are growing concerns that the UK economy will be unable to spend its way out of a recession and considering that manufacturing only contributes to roughly 15% of gross domestic product, it is becoming increasingly difficult to see a solution, particularly with housing and services in a downward spiral.
As a result, the Pound may drop as low as $1.4500 over the next week and that trend may also continue against the Euro as we approach the all time record low under 1.1600 with a further 50 basis point interest rate cut scheduled for December.
UK stocks also plummeted for a second consecutive day as a record number of U.S jobless claims sparked fears that the global recession is deepening and the Dollar also fell against the Euro as traders speculated that the Senate’s plan to bailout automakers will reduce demand for the security of U.S assets.
The Japanese Yen fell against the Euro and the Dollar as U.S stocks erased earlier losses and encouraged speculation that investors will halt the sale of high-yielding currencies funded by low cost loans in Japan.
That sentiment was emphasised in the performance of the Swiss Franc, which is also considered a ‘safe haven’ asset, as the currency decreased to the lowest level against the Dollar since July 2007 after the Central Bank unexpectedly halved its target lending rate to 1.0%.
However, the Australian and New Zealand Dollar, along with the Canadian Dollar also came under renewed selling pressure against the Pound as the increased appetite for risk aversion still stalks the market.
Concerns over the future of U.S automakers saw the Dollar decline 0.4% versus the Euro as senators reached a bipartisan agreement on a bailout plan that may yet fail to find majority support in Congress.
Elsewhere, initial jobless claims in the U.S climbed to a higher-than-expected 542,000 in the last week as the number of Americans filing for unemployment benefits approached the highest level in 26-years and that reflects the worsening economic outlook.
In addition, an index of leading economic indicators that is used to gauge the future performance of the economy declined 0.8%, while a measure of manufacturing in the Philadelphia region sank to an 18-year low and the reports combined show that the U.S economy is in the midst of a recession that may spark a period of deflation.
Data Released 21st September
EU 09:00 Flash PMI – Manufacturing (November) – Services
The Pound enjoyed a significant intraday rally against the Dollar yesterday, rising as high $1.5247 on the session, before falling back under $1.5000 at the close of trading last night, while the UK currency also met resistance just under 1.2000 versus the Euro following the release of the minutes from the BoE’s last policy meeting.
The Bank’s monetary policy committee slashed UK interest rates by 1.5% earlier this month and the report yesterday indicated that policy makers are willing to cut rates again in an attempt to revive the struggling economy.
There is a growing sense that the Central Bank acknowledge they are well behind the curve on monetary policy and policy makers are ready to be more aggressive in addressing the risks to economic growth as the minutes showed that the MPC even considered a larger reduction in November.
In the aftermath of the report, the Pound remained largely unchanged but through the session the UK currency began to make gains against the majors, climbing 2% versus the Dollar and investors are still adamant that sellers of Sterling should take advantage of the mini revival with further losses likely to come.
According to the minutes, policy makers led by the governor of the Bank of England Mervyn King, discussed the possibility of lowering rates below 2.5% before the MPC voted unanimously to reduce borrowing costs to 3.0%, the lowest level since 1955.
Policy makers limited the reduction to 150 basis points because they wanted to wait for details on the government’s tax plans and assess the effects of the state rescue of a number of struggling financial institutions before another projected 50 basis point cut on December 4th.
A report from the Office of National Statistics earlier this week showed that the annual pace of UK inflation recorded the biggest single drop in at least 11-years last month as the economy contracted and Mervyn King conceded just last week that the Central Bank is prepared to cut rates and prevent deflation from taking hold.
The minutes from the report showed that projections in the UK inflation rate implied that a significant reduction in the lending rate, possibly in excess of 200 basis points, might be required in order to meet the 2.0% inflation target in the medium term.
Consumer prices have risen 4.5% year-on-year in October, compared with 5.2% the previous month and the significant drop has fuelled concerns that a slowing economy will see the economy enter a period of deflation as producer costs also tumble and output prices contract at the fastest pace in 22-years.
Some would argue that policy makers are actively trying to undermine confidence in Sterling as a weaker currency will help bolster growth but MPC member Timothy Besley said yesterday that the weakness in the Pound probably won’t prevent inflation from slipping under the 2% target next year.
The Euro declined on the session against the Pound yesterday but enjoyed a strong intraday move versus the Dollar despite a fairly damning assessment from the ECB President Jean-Claude Trichet, who said that the global economy is experiencing the worst financial crisis since the end of World War Two.
Europe’s economy has fallen in its first recession in 15-years in the third quarter of this year after the credit crisis pushed up lending costs and triggered the collapse of the third largest U.S investment bank Lehman Brothers Plc in what could be considered the worst financial crisis since the Great Depression.
The European Central Bank have lowered interest rates to 3.25% over the past month and the Euro’s momentum against the Pound has stalled amid speculation that the Central Bank will be just as aggressive as the Bank of England in lowering borrowing costs.
The Dollar came under a large degree of selling pressure yesterday as the U.S currency extended its decline against the Pound following reports that U.S consumer prices fell at the fastest pace on record as the cost of living fell and construction began on the fewest number of homes ever last month.
The currency market has been dominated by swings in risk sentiment in recent weeks but yesterday U.S fundamentals came back into focus as the headline consumer price index plunged 1.0% in October, the most since records began in 1947.
The scale of the decline indicates a period of deflation, or a prolonged price slide, which may become another hazard facing the Federal Reserve and that could worsen the economic outlook by making debts harder to pay off and offsetting the positive impact of a series of interest rate cuts.
The Pound was unable to sustain Monday’s momentum against the majors yesterday as the UK currency found strong resistance at $1.5000 against the Dollar and also fell back under 1.1900 versus the Euro as traders speculated that the bounce may have been nothing more than a technical consolidation before a further downside move.
Sterling sentiment was further undermined as former Chancellor of the Exchequer Norman Lamont conceded that the Pound’s recent slide will help the UK economy pull out of a recession as long as it doesn’t turn into a “run” on the currency, a view echoed by BoE governor Mervyn King, who has publicly refused to rule out cutting interest rates to zero per cent in an attempt to bolster growth.
Lamont was the finance minister during the last currency crisis in 1992 and he said in an interview yesterday that “there are opportunities when a currency depreciates but as so often when you have these situations, what starts as a small move can quickly become a run”.
The Pound has lost 24% in value against the Dollar alone this year and has shrank to an all time record low versus the Euro as the monumental decline in value is reminiscent of events in 1992 when Lamont failed to prevent a sell-off in Sterling that eventually pushed the currency out of the European Exchange Rate Mechanism during John Major’s tenure as UK prime minister.
JP Morgan & Chase Co have predicted that the Pound will extend its current slump to the lowest level since 1985 with the UK currency forecast to hit $1.2800 versus the Dollar next year and fall as low as 1.0900 against the Euro amid concerns of deepening and prolonged UK recession.
Investors are encouraged to keep selling Sterling as Gordon Brown’s government steps up spending and implements a series of tax cuts to boost consumer sentiment but that will only serve to widen the biggest budget deficit since the Second World War.
The UK Treasury has a budget gap of £37.6 billion in the first half of the fiscal year as the government deliver tax breaks to low income earners, increases public spending by £4.8 billion while delaying an increase in fuel duties and helping homeowners with mortgages by removing stamp duty taxes.
Lamont also defended George Osborne in the interview yesterday after the shadow Chancellor was criticised by Gordon Brown for saying that the government risks creating “a proper Sterling crisis” and needed to be more responsible for his comments. Lamont stated that Osborne had been unfairly criticised for his comments as he had only stated what other people had been saying, while he stopped short of reccommending that the UK adopts the Euro as the Pound deteriorates.
The Bank of England have cut UK interest rates below the European Central Bank for the first time since the Euro was introduced in 1999 this month as the benchmark lending rate slides to just 3.0% compared to 3.25% in the Euro-region and investors are anticipating further cuts in the December 4th meeting.
A government report yesterday showed that the UK inflation rate had the biggest drop in at least 11-years in October as consumer prices slowed from 4.5% from 5.2% in September and the Pound declined as the tone of the report gave policy makers further scope to reduce interest rates.
An earlier report from the Confederation of British Industry, Britain’s biggest business lobby, indicated that the UK economy will contract the most in almost thirty years in 2009 and despite the Euro-zone entering its first recession since 1999, the Pound is forecasted to register further losses against its European counterpart in the short-to-medium term.
The focus this morning will fall on the minutes from the Bank of England’s last policy meeting and the report may provide an indication of how far policy makers are willing to cut interest rates, while traders will also be particular attention to the voting pattern of the nine-strong monetary policy committee.
A unanimous vote to cut rates by 1.5% earlier this month is likely to be negative for Sterling, while a separate report from the CBI should also point to further weakness in the manufacturing sector as industrial orders slump to a reading of -41 in November from -39 the previous month.
The Dollar bounced back against both the Pound and the Euro yesterday amid renewed speculation that overseas investors sought the security of U.S assets as a strong element of risk aversion saturated the market and the global economy entered a recession.
The Dollar index, which provides a measure of the U.S currency against a basket of trading partners, approached the highest level in 2-years before data from the Treasury today that is expected to confirm that overseas investors almost doubled holdings of the nation’s securities in September.
The increase in risk aversion and sustained decline in oil prices is likely to be positive for the Dollar in the month’s ahead, while the greenback also found support yesterday as U.S producer costs plunged by the most on record in October as the declining outlook for the world economy sapped demand for commodities.
The 2.8% drop in prices was much larger than forecasted and the report precedes a broader measure of U.S inflation this afternoon, which may show that consumer prices also tumbled in October as the cost of living slides by the most in 60 years and helps propel the economy back from the brink of recession.
Once again Senior Traders Adam Solomon and Luke Trevail analyse the news in the currency markets and look ahead to what might happen on the trading floors in the coming week.
This week:
Mervyn King’s Comments on Sterling
The Eurozone’s economic resistance
JP Morgan’s gloomy predictions
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